Archives for June 2022

With industry fundamentals continuing to strengthen following a steep dip during the pandemic, some hotel investors are back in building mode.

Travelers are booking hotel rooms again. After a brutal slowdown during the depths of the pandemic, U.S., hotels have recovered and occupancy rates are almost as high as they were in 2019 with average daily rates even exceeding pre-COVID levels.

Strong fundamentals have created incentives for hotel developers to get building again. But they are struggling with a new set of challenges, including a shortage of construction workers, huge demand for construction materials, continued supply chain disruptions and rising interest rates. All of that has meant that while development is happening, far fewer new hotel rooms are in the pipeline than the industry average before the pandemic.

“I think developers will take a breather this summer to see how interest rates and the overall economy develop, and then jump back in in the fall when there is a bit more visibility,” says Jan Freitag, national director of hospitality market analytics for CoStar. “Strong projects still work, it will just take a little bit more time to get them done.”

Roughly two-thirds (65.1 percent) of the hotels rooms in the U.S. were occupied in May 2022, according to CoStar. That is just a little lower than the occupancy rate (68.5 percent) in the same month the year before the pandemic, in May 2019. It is a vast improvement from May 2020, when just one-third of rooms were occupied.

And revenues have recovered as well. The average daily rate (ADR) was $149.91 in May 2022, up from $132.14 in 2019 and nearly twice the ADR of $79.56 in May 2020, according to CoStar. The revenue per available room (RevPAR) was $97.53 in May 2022, up from $90.52 in 2019 and more than three times the RevPAR of just $26.32 in 2020.

“Hospitality is in a good spot given the wreckage in the last two years,” says Amit Govin, principal and CEO at Everwood Hospitality Partners. “And that’s without significant corporate demand buffering RevPARs.”
Developers are most interested in building the kinds of hotel properties that are showing the strongest performance.

“Extended stay hotels and assets in leisure locations have been the clear winners over the last two years,” Govin adds. “Owners and developers have taken note.”

Developers are also most interested in the parts of the country where people seemed eager to move during the pandemic.

“We continue to look for opportunities to develop premium, select-service brands in Florida, the Southeast, the Midwest and the Sun Belt—markets that have been net beneficiaries of population and demand migration since 2020,” says Will Woodworth, vice president of investment for Peachtree Hotel Group.

Developers are least interested in building properties like full-service hotels, which have still not regained the demand from business travelers and often suffer with staffing problems.

“In the current climate there are only a few key full-service hotel developments in the pipeline,” says Twenty Four Seven Hotels’ Wani. “The excessive labor costs to operate large, city center hotels are becoming cost-prohibitive.”

Developers still build less than before coronavirus

As more people have rented hotel rooms, developers were able start construction on projects they had planned before the pandemic.

“We are still working through our pipeline of pre-pandemic projects,” says Peachtree’s Woodworth. “We have benefitted from picking sites three years ago that have actually showed improved fundamentals post-pandemic.”

Developers had 150,000 new hotel rooms under construction in May 2022, according to CoStar. That’s a lot less than the 212,000 new rooms they had under construction in March 2020, as the coronavirus pandemic began.

“Projects which were well-conceived were able to obtain construction funding in summer and fall of 2021 and commence construction shortly thereafter,” says David Wani, co-founder and CEO of Twenty Four Seven Hotels.

Developers are also starting work on new plans to build hotel rooms.

“Faster-than-expected RevPAR recovery is making some developments feasible again,” says Everwood’s Govin.

However, these new developments are hard to begin. “There are still properties breaking ground but in general, it is harder and harder to do,” says Freitag.

Developers have been shocked by sudden increases prices for the materials they need to build new hotels—from appliances to lumber. These prices have been volatile for more than a year.

“You really don’t know how much the project will cost until you are at the final pricing set,” says Peachtree’s Woodworth. “Even at that point you may be surprised by a sudden lack of sub-contractor availability, materials pricing fluctuations, etc.”

Lenders charge higher and higher interest rates

Developers are also getting less money from lenders, and they are having to pay higher interest rates for those smaller loans.

“There is tremendous dislocation in the debt markets,” says Kevin Davis, CEO of JLL Hotels and Hospitality, Americas. “If you are starting a process right now it is significantly harder today than six months ago.”

Short-term interest rates are marching higher as officials at the Federal Reserve increase their benchmark interest rates, with more increases expected later this year. Lenders are also charging more, adding to the challenge of financing hotel projects. “Lenders are widening their spreads,” says Peachtree’s Woodworth.

Lenders are also looking more closely at the hotel developments that apply to them for financing. “Lenders prefer branded hotels with top franchisors such as Marriott, Hilton, Hyatt and IHG and segments such as extended stay, upscale and lifestyle,” says Twenty Four Seven Hotels’ Wani.

“Most lenders are concerned about supply chain and rising development costs,” says Everwood’s Govin. “This is placing more (hopefully just transitory) constraints on proceeds and loan-to-cost levels than we’ve seen in the past.”

Source: “Hotel Developers Battle Rising Construction Costs to Build More Rooms“

The rate of increase has turned the corner and is on its way down.

CRE prices are still rising, but the rate of growth for most types seems to have hit the top and has tipped over on the downward slope, according to data from MSCI’s Real Capital Analytics.

“Price growth for US commercial properties hovered just below recent record highs in May, supported by price gains in the industrial and apartment sectors,” the firm’s report said. “The RCA CPPI National All-Property Index climbed 18.6% from a year ago, slightly down from the record annual growth of 19.3% seen in January.”

This is not the first indicator that CRE price growth is slowing.

The rates are uneven across property types, as Real Capital Analytics graphs show. Industrial prices were up year over year a record 28.6% in May 2022 and 1.8% over April. “Prices on traded properties have remained robust even amid signs of potential cooling in the market, as industrial deal volume retreated for a second consecutive month in May,” the report said.

Multifamily also was at an all-time high for the second month in a row, at 23.3% growth. “The index for retail properties increased 18.8% from a year ago,” explained Real Capital Analytics. “While still a significant double-digit growth rate, the pace has eased for three consecutive months.”

After that, growth was much slower. Office saw a 12.2% year-over-year lift, an average of property types pushed up by central business district office price growth of 13.4%. The latter was the fastest growth for CBD offices in eight years. Suburban offices, which were supposed to be a hotter commodity during the pandemic, were up 10.5%

That’s the good news for investors. However, a closer examination of the graphs suggests that price growth may be hitting a ceiling and turning a corner. That’s all back to calculus and the second derivative, which is the pace at which change is varying. Even while prices continue to rise, the pace is slacking off, though at current trends, it will take some extended time for industrial, apartments, office, and even retail to come closer back to pre-pandemic levels.

That’s assuming no significant change in current conditions, but that’s hardly a given. Yes, price growth could continue if cap rates keep compressing, and they might. But inflation and increasing financing costs might take a toll. Interest rate caps prices are so high that they’re already quashing many dollars in deals. Plus, cap rate compression can only continue if cash flow from rentals can rise fast enough for investors to accept higher costs. With inflation at 8.6% at last count, it’s unclear whether people and small businesses can continue to bear increased rents.

Source: “CRE Price Growth Still High … For Now“

One reason is that more space was placed on the market in CBD locations.

Suburban markets are leading the post-pandemic office sector recovery, with absorption hitting 2.2 million square feet in the first quarter.

By contrast, CBD office markets posted negative 2.6 million square feet of absorption during the same period. CBDs have struggled since the onset of the downturn, with vacancy rates rising by 470 basis points over the past eight quarters compared to 280 basis points in the suburbs.

Vacancy levels in CBD and suburban markets are now equal at 15%, marking a first for the metrics. But Colliers experts say the equilibrium can be attributed to a combination of more space being placed on the market in CBD locations as well as a higher share of new deliveries in those markets. Vacancy fell in 50% of suburban markets in the fourth quarter, and by 46% in CBD locations.

Earlier this year, Colliers US CEO Gil Borok told CNBC that the firm is seeing more interest in suburban markets from buyers.

“Pretty much anywhere where there’s a lesser commute or you’re in a suburban area or a less dense area—that’s from an office standpoint where folks are most likely to return,” he said. “And in terms of opportunities, if you’re an investor, obviously those markets follow suit.”

Colliers also points out that office investment activity is approaching pre-pandemic levels, with total sales volume in Q1 2022 ticking up 59% year-over-year to hit $35.1 billion and office values rising 10.3% year-over-year. Again, suburban markets are attracting the most investment, with buyers socking $23.5 billion into suburban assets in the first quarter. By way of comparison, CBD locations saw just $11.6 billion in new investment in the same period.

Pricing was $293 per square foot on average in the quarter, with averages hitting $392 psf in CBD markets and $264 psf in suburban regions.

Sales activity was dominated during the quarter by two deals in New York City comprising a combined $3.5 billion: Alphabet Inc.’s $2.1 billion Hudson Waterfront purchase for Google’s New York headquarters and Blackstone’s purchase of One Manhattan West for $1.4 billion.

Source: “For the First Time CBD and Suburban Office Vacancies are the Same“

A continued need to adapt and the potential to feel isolated spur alternative locales.

Hyper-hybrid workers are finding both good and bad with their new weekly working patterns, according to a new report by JLL.

The most empowered set of office workers, they are also dealing with the highest mental wellbeing challenges, JLL said, such as the continued need to adapt and the potential to feel isolated.

“As a result, ‘hyper-hybrid’ workers feel more stressed and need sustained employer support to recreate healthy routines and a sense of belonging with their team,” Flore Pradère, Work Dynamics Research Director at JLL, said in the post.

In response, these workers are finding third places to work—somewhere other than their home or company office—choosing to log-in at cafés, hotel lounges, and coworking spaces, according to JLL’s latest Workplace Preferences Barometer.

The relief can come from this because it doesn’t require working “alone.”

“External venues offer small teams the opportunity to come together and collaborate in a very professional environment,” Pradere said. “This type of place also favors connections with people from outside the organization. The change of scenery in itself can bring benefits, both for groups and individuals seeking inspiration.”

Some 36% of employees work in such “third places” at least once a week, up 8% from a year ago, JLL’s report found. One-third said they are considering this work arrangement in the future.

This trend not only impacts office usage patterns but also opens up opportunities for new offerings by these retail establishments. For instance, before the pandemic some hotels had begun offering lobby space as a place to work and network for workers tired of their office’s four walls.

There are shades of the mental health issues these offering monetized—and described by JLL—in a study released Wednesday by hybrid office software company Eden, which found that full-time remote work is the least popular option among tech workers, though the vast majority (95%) say it’s important to have the ability to work remotely at least occasionally.

When asked about their preferred way of working, hybrid work was the most popular option among tech workers: nearly half (48%) of respondents said they prefer hybrid work, compared to 34% who selected full-time in-office and 18% who said full-time remote.

Gen Z tech workers’ No. 1 work preference is working full-time in the office, while the millennials (50%) and Gen X (47%) of tech prefer hybrid work arrangements. 42% of baby boomers cited full-time remote work as their preferred arrangement.

JLL’s Pradère added, “The need for support for employees—from managerial support to interaction with colleagues—transcends locations and workplace options. There’s an expectation to be supported by employers in new workstyles.”

Source: “‘Hyper-Hybrid’ Workers Find a Third Home“